If Fed cuts rates the dollar will fall? History shows it's never so simple.

By William Watts

Deep rate-cut cycles weaken the dollar, but shallow ones not so much: SocGen

Once the Federal Reserve begins cutting interest rates, the U.S. dollar will surely fall and begin a downtrend, right? Alas, it's never so simple.

Check out the chart below from Kit Juckes and Olivier Korber of Société Générale, tracking the ICE U.S. Dollar Index DXY against the fed-funds rate over the past four decades.

The strategists summarize:

In 1985, the dollar fell a long way, but not until four months after the first rate cut. In 1989, it started falling within days of the first cut, but it then rallied between the first and third cuts in [1995/96]. In 1998, it fell before the Fed cut rates as LTCM collapsed. In 2000, it was falling when the Fed started to ease. It bounced in 2001 and finally fell sharply in 2002-04 as rates went on falling. It mostly fell as rates rose in 2004, and although it bounced in 2005, it was already falling again long before the Fed easing in 2007. The only rate-cutting cycle since then started in July 2019, and the dollar fell for a few months and was still falling when COVID made its unwelcome appearance...Unprecedented Fed easing did produce a significant dollar fall in 2020 of course!"

If there's a lesson for investors and traders it's that a protracted Fed easing cycle is likely to weaken the dollar, but a brief, shallow one (as exemplified by 1996 and 2019) might not trigger much of a reaction as money flows into U.S. assets, the strategists said.

Need to Know: The lesson from 17 first cuts of the cycle is more sobering for the stock market than it appears

What about now? They noted that the current dollar peak is the highest in real terms since 1984-85, narrowly exceeding the 2002 high. In both cases, the dollar saw a delayed reaction but a substantial fall, though in both cases the decline was accompanied by significantly deep Fed rate-cutting cycles.

"The current dollar's level, and the size of the positioning that got it there, argues for a big move," they wrote. "Expectations that the Fed can ease, avoid a recession and see U.S. economic exceptionalism persist argue for caution."

-William Watts

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07-24-24 0931ET

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